This value is most descriptive in comparisons. Use these guidelines to interpret relative earnings yield values:
- A higher earnings yield can indicate low valuation and higher potential returns. Two factors push an earnings yield higher: a falling stock price or rising earnings. If the yield is higher because the stock price has dipped, you should evaluate the permanence of the decline. A short-term pullback in the stock price can indicate a buying opportunity; a long-term decline is something to avoid.
- A lower earnings yield can mean the stock is overvalued and has less upside. However, an overvaluation relative to historic earnings can be justified when the company's growth expectations are high. Look into the company's outlook as a next step.
Using earnings yield
Earnings yields have two primary uses in financial analysis. The first is comparative. You can compare a stock's earnings yield to competitors, benchmarks, and other asset classes.
For example, analysts will compare the S&P 500 earnings yield to bond yields when evaluating the relative return potential of equity vs. debt investing. Often, the equity earnings yield is higher. The difference is called the equity risk premium -- which theoretically compensates equity investors for accepting the greater volatility of stocks vs. bonds.
Earnings yields are also an alternative to the P/E ratio for companies with negative earnings. Many financial publishers do not calculate or provide negative P/E ratios because their interpretation can be confusing. In these situations, the earnings yield is easier to compare and analyze.
